The DAO Diversification Imperative

By Andy Kangpan on February 2, 2022

Decentralized Autonomous Organizations (DAOs) saw an unprecedented rise in popularity in 2021. In a span of a year, DAOs went from a backseat narrative in the crypto ecosystem to a top of mind conversation for nearly everyone both inside and outside of the Web 3 industry (including a short piece in The New Yorker). Furthermore, DAOs have become a point of emphasis when considering the technological innovations driving the Web 3 movement. There are immense implications of decentralized organizations that manage a treasury through on-chain community governance and I anticipate that they will reverberate not only through the crypto ecosystem, but through society as a whole.

Figure 1: Interest in DAOs surged in popularity over the course of 2021 according to Google Search Trends Data

Alongside this growth, the treasuries that these organizations manage have exploded in notional value. Although hard to precisely calculate, some have reported that assets in DAO treasuries grew by more than 40x from the beginning of 2021 to mid-September. It is amazing to stop and realize that there are billions of dollars being managed by decentralized communities seeking to drive innovation forward in the Web 3 ecosystem.

However, a major challenge facing DAOs is the lack of diversification in their treasuries. The majority of these organizations hold only their native tokens, with many others only having about 5% of their value diversified into other assets. Given this lack of diversification, these treasuries face an extreme risk in the form of price volatility. If these organizations hold all of their value in their native token, any major swing in price will completely change the resources at hand to fund ongoing operations. Without adequate diversification I expect to see DAO treasuries shrink in value in the next bear market as quickly as they surged in 2021.

Solving this challenge is an imperative for any DAO looking to sustain their operations throughout any market cycle.

There is no silver bullet for this challenge. Rather, DAOs will have a range of tools available to help bring the portfolio of assets under management to a healthier state of diversification. Today, there are a couple of common approaches that DAO’s take:

  • OTC Sales – in this model, DAO’s sell a portion of their treasury to investors in exchange for stablecoins. These deals are done OTC through private conversations with institutional investors and/or through a direct public sale, at a discounted rate to the current trading price.
  • Governance Token Swaps – in this model DAOs swap their governance token with a partner protocol. This approach has the benefit of treasury diversification in addition to cementing strategic partnerships with projects that have mutually aligned goals.

Outside of these approaches there are very limited tools available today for protocols to achieve their diversification targets. However, there are a number of interesting tools emerging that may have useful applications in the context of treasury management. For example, decentralized derivatives exchanges such as PsyOptions and Zeta Markets seek to provide DAOs (and network participants more generally) with the tools to properly hedge positions they may hold in their treasuries. Another example is the emergence of fixed-rate protocols such as Pendle and Element Finance that offer DAOs the ability to lock in fixed yield on their deposits.

I expect DAO diversification to be a hot topic in this next phase of the ecosystem’s growth. In a crypto bull market, diversification is often more of an intellectual exercise than a practical consideration. However, as we’ve begun to move into a more volatile crypto market from a price perspective (as of this writing the global market cap of crypto has declined from ~$2.5T to $1.75T in the past 30 days), I expect the financial solvency of decentralized organizations to be seriously challenged and only those who have been properly diversified will find it relatively easy to weather the oncoming storm.

But what does it mean for a treasury to be diversified? I also expect this to become a big point of debate as the topic of diversification becomes more top of mind. Clearly, having all of a treasury’s value in the native currency is not ideal from a diversification perspective, but there are many considerations to weigh with not very much agreement in the context of crypto. These considerations include:

  • Should the DAO’s focus be on bringing on other governance tokens into the treasury?
  • Would it be more effective to bring on major blue chip tokens such as BTC, ETH, and SOL? 
  • Should the DAO focus specifically on stablecoins or even fiat? 
  • What proportion of the treasury to diversify away from the native token?

Where DAOs want to fall relative to the efficient frontier is ultimately affected by many considerations such as the runway to fund development activities and the risk tolerance of the community. No matter where organizations fall, I think it is clear that as DAOs become an increasingly common organizational model for technology innovation there will be an increasing demand for tools that help diversify the treasury of its resources to ensure its initiatives are properly funded.

If you are a founder thinking about DAO diversification, we’d love to chat with you!

This article is not an endorsement by Two Sigma Ventures, LP, or any of its affiliates (collectively, “Two Sigma Ventures”) of the topics discussed. The views expressed herein are solely the views of the author(s), are as of the date they were originally posted, and are not necessarily the views of Two Sigma Ventures. They are not intended to provide, and should not be relied upon for, investment advice. Your linking to or use of any third-party websites is at your own risk. Two Sigma Ventures disclaims any responsibility for the products or services offered or the information contained on any third-party websites.